Equity premium estimates from economic fundamentals under structural breaks

This article compares three estimates of the conditional equity premium using dividend and earnings growth rates to measure the expected rate of capital gain. The premia are estimated using a theory-informed Bayesian model that admits structural breaks. The equity premium fell from 8.16% in 1951 to 1.15% in 1985. Approximately half of this decline was reversion of a high conditional premium to the long run mean and the remainder resulted from a decline in the expected stock return. The decline in the expected stock return was largely driven by the Fed Accord (1951) and the Fed's 'monetarist policy experiment' (1979-1982).